Abstract
Although banks possess superior liquidity risk management skills, the financial crisis of 2007-2009 severely affected their liquidity buffers. This led to increasing concerns by regulators on the adverse effects of reliance on unstable wholesale funding. Building on the growing literature on bank wholesale funding, this paper examines the effect of wholesale funding on liquidity creation, the main function of banks in the economy through which they fund illiquid loans with liquid deposits. Consistent with the recent criticism of the role of unstable funding, our findings suggest that (especially short-term) wholesale funding can have a negative effect on liquidity creation which can be attributed to greater exposure to liquidity shocks. Our results are robust to several tests that address concerns about potential endogeneity and other issues.
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